Tests Ahead for U.S. as Strains on Sovereign Debt Collide with Basel III Capital Framework
August 16, 2011 in Banking Report
Heightened worry about the reliability of U.S. government securities and other sovereign debt is a major wild card as regulators look to implement new bank capital standards under the Basel III framework, experts say.
President Obama and congressional negotiators offered some short-term relief late July 31, reaching an accord to avert a default on U.S. debt and lessen the odds of a downgrade by the major rating agencies.
However, ongoing confrontation over the budget, and the potential for adverse action by the rating agencies, underscore growing questions about the role of government debt securities under the latest bank capital framework sponsored by the Basel Committee on Banking Supervision.
Bankers have a full workload, especially in terms of new mandates under the Dodd-Frank Wall Street Reform and Consumer Protection Act.
But capital standards and regulations consistently rank at or near the top of bankers’ concerns and compliance responsibilities.
Low Risk-Weighting at Risk
For the most part, capital standards have given sovereign instruments a zero risk-weighting, meaning they are risk-free and require no extra capital.
However, one look at ongoing turmoil in the European Union is enough to puncture that balloon, according to Karen Petrou, managing partner of Federal Financial Analytics, a Washington, D.C., financial services consulting firm.
“The invincibility of sovereign debt isn’t just dubious, it’s laughable in the EU, where major national issuers are suffering from acute solvency woes only barely managed through the most recent bailout,” she said in a July 29 memorandum.
Central bankers are watching. In a July 11 report, the Committee on the Global Financial System, a Basel panel chaired by Bank of Canada Governor Mark Carney, said mounting questions about the ability of governments to repay their debt could weaken major banks and destabilize the global financial system.
Risk-Free Assets Disappearing
The handling of national debt is making risk-free assets disappear in a way that calls into question the core assumption of the Basel structure, Institutional Risk Analytics Cofounder Chris Whalen told BNA Aug. 1.
“The whole premise of Basel is that it’s a risk-weighted framework. The problem is that the risk-weights don’t make any sense any more,” said Whalen, whose Torrance, Calif., firm provides ratings and consulting services for auditors, regulators, and financial professionals.
Fred Cannon, director of research and chief equity strategist at Keefe, Bruyette & Woods, Aug. 1 said the latest questions fit the trend.
The Basel II Accord gave home mortgages a low risk-weighting, right before the market for residential loans tanked.
Now, Basel III envisions low risk weights for sovereign instruments, just in time for the latest crisis.
“The challenge for Basel continues to be that it’s always focused on the last problem. Basel II was very mortgage-friendly, and Basel III is very sovereign risk-friendly,” Cannon told BNA…